|
Q: In
your opinion, what caused the financial industry crisis?
Marc Lepage, Dudley, Massachusetts
A: The
list of possible culprits is long indeed: Congress, for
overzealously pushing homeownership; the Federal
Reserve, for keeping interest rates so low; predatory
lenders, for taking advantage of unqualified and
sometimes vulnerable home buyers; and home buyers, for
getting in over their heads.
The list
goes on: the White House, for letting banking
regulations become too loose; finance executives, for
selling products they didn’t understand while enjoying
outsize profits; mark-to-market accounting, for
accelerating the downturn; rating agencies, for
mischaracterizing paper; and short-selling hedge funds,
for betting on doomsday—thereby ushering it in.
It
reminds us of Agatha Christie’s Murder on the Orient
Express. There was just one victim in the middle of
the night, but plenty of passengers made strong
suspects. And we’ll add another: the transformation of
investment banks from private partnerships to publicly
traded companies. That trend, which began in the
mid-1980s because of a justifiable need for more capital
in an expanding global economy, may have just played out
its most unfortunate unintended consequence.
In the
old days, investment banks were owned and operated by
partners putting much of their own wealth at risk. They
were rewarded when business went well and personally
felt the sting when it didn’t. No wonder, then, that
partners lived and breathed the risk profile of every
significant trade, deal and position.
Then
came the investment-bank IPO parade, starting with Bear
Stearns in 1985 and ending with Goldman Sachs in 1999.
With every pubic offering, some partners cashed out.
Those who remained kept the wheels moving, only with
other people’s money—and lots more of it.
One of
us (Jack) had a small, early taste of the impact when GE
acquired investment bank Kidder Peabody in 1986.
Although not technically an IPO, the deal had the same
effect because of GE’s enormous balance sheet. Less than
two weeks after the close, a group of excited Kidder
investment bankers showed up at Jack’s office pitching a
$400-million bridge loan to finance an
oil-and-gas-industry transaction, a high-risk deal they
probably wouldn’t have dared propose in their prior
partnership.
They got
it, and after several other creative uses of GE’s
balance sheet, it became clear GE didn’t have the
expertise to manage an investment bank, and it sold
Kidder in 1994.
As
shareholder-owned investment banks started taking on
larger risks on larger positions, something else started
getting larger, too—bonuses. The result was like Vegas
on Wall Street. Working the same hours, at the same
intensity, but now leveraging someone else’s money
instead of their own, anonymous financial engineers were
suddenly carrying home $5 million, $10 million, $20-plus
million a year.
To keep
that game going, most took on ever more risk with ever
more exotic instruments. And what if a deal or trade
went bad? A smaller bonus, but without personal wealth
on the table—so no downside. Is it any surprise that
pricing risk in an appropriate manner went out the
window?
We don’t
peg the whole financial crisis on public investment
banks. They’re just another passenger on the Orient
Express. But we mention them so that in the cleanup
that’s about to ensue, all culprits get their due. And
without question, the out-of-whack compensation system
on Wall Street should be dealt with as part of any
government intervention. There has to be greater
long-term alignment with shareowners.
As for a
cleanup, there will be one. This crisis is mind-numbing
in its complexity and global scope, but previous
meltdowns have proved that broken systems can be fixed
by smart people. Treasury Secretary Henry Paulson,
Federal Reserve chairman Ben Bernanke and Timothy
Geithner, president of the Federal Reserve Bank of New
York, fit that description. Ideology hasn’t blinded
them, and they’ve proved fast and flexible in
anticipating a next move when a first one didn’t do
enough.
We don’t
know how or when this crisis will end, but we have
confidence that the team in charge will put the system
back on the long road to better days.
*****
Jack
and Suzy Welch are the authors of the international
bestseller Winning (Collins). Their latest book is
Winning: The Answers: Confronting 74 of the Toughest
Questions in Business Today (Collins). They are eager to
hear about your career dilemmas and challenges at work
and look forward to answering your questions in future
columns. Please visit their new website at
www.welchway.com and submit questions through the online
form at welchway.com/Contact-Us.aspx. Please include
your name, occupation, city and country. |
